Why Beijing’s Efforts Have Failed to Tame China’s Stock Market

Since the last week of June, the Chinese government has intervened in the country’s stock markets nearly every day to stop their steep slide. But the harder Chinese authorities try, the more it looks like they are losing control.

The Shanghai Composite Index fell 5.9% on Wednesday and is down nearly one-third from its peak on June 12. Since then, $3.5 trillion in value has been erased from companies in the benchmark index—or nearly five times the size of Apple Inc.

China’s bond market and currency also began to get hit Wednesday as worries deepened that a contagion from stock-market losses could further trammel the country’s slowing economy. It felt even more ominous because Chinese officials had rushed out another raft of emergency measures earlier Wednesday to reassure the market.

The moves only heightened what is turning into an epidemic of anxiety among Chinese investors and a crisis of confidence in their leaders. Stocks were volatile early Thursday.

“The more the government intervenes, the more scared I am,” said Li Jun, who runs a fishing and restaurant business in the eastern city of Nanjing. He has spent about 3 million yuan, roughly $500,000, on stocks, using borrowed money for about one-third of the total.

Mr. Li has sold some of his investments every time the market “popped up a little” following a rescue announcement by the Chinese government. “I have no faith” in its ability to halt the losses, he says. Wednesday’s drop left the Shanghai index down 32% from its peak and at its lowest level since March.

The latest drastic step by Beijing is a six-month ban on stock sales by controlling shareholders and executives who own more than 5% of a company’s shares. Any violation of the rule, announced Wednesday night, would be “treated seriously,” China’s securities regulator said.

Early Thursday, China’s central bank said it has provided “ample liquidity” to a company owned by the country’s top securities regulator. The company is lending the funds to securities firms, which then will use the money to buy stocks.

The Chinese government has been praised for driving decades of economic growth and keeping the economy strong during the global financial crisis. In recent years, Chinese authorities have struggled with rising debt levels and the need to reform the economy away from government-driven infrastructure programs and toward consumer spending.

As it fought slower growth and a weakening real-estate market, the government turned its attention to the country’s languishing stock markets.

But Beijing’s inability to stop the recent decline has rattled investors who have long been used to seeing the government use its power to control markets.

“Beijing’s latest bid to calm the market has had the opposite effect,” said Bernard Aw, market analyst at IG Group. “The panic is spreading, and authorities appear to be grasping at straws to hold back the tide.”

U.S. Treasury Secretary Jacob Lew played down the possible world-wide impact of China’s stock-market mess, though he expressed worry that it could restrain the country’s longer-term growth if Beijing slows its promised economic overhauls.

“The concern that I think is a real one is, what does it mean about long-term growth in China?” Mr. Lew said Wednesday.

One worry is that bruising stock-market losses could force millions of Chinese investors to rein in personal consumption, which might hurt companies that sell goods in China.

For example, China is the biggest market for Indian auto maker Tata Motors Ltd. TTM -6.78 % ’s Jaguar Land Rover vehicles. U.S.-listed shares of Tata fell 6.8% on Wednesday.

The Chinese government’s struggle to prevent distress from spreading is a sign of how much it fueled runaway investor optimism in its push to drive company share prices higher.

Just a year ago, stocks were languishing at multiyear lows, and few Chinese savers saw stocks as a good investment. The real-estate market, where many Chinese put their money, was slowing. Beijing hoped to use a rallying stock market to boost the economy and speed economic reform.

The stock market’s rally began in November, when Beijing cut interest rates and granted international investors unprecedented access to its main stock market in Shanghai. Local investors interpreted the move as a vote of world-wide confidence in the outlook for Chinese stocks.

Accompanied by a stream of upbeat editorials in state-run media, the Shanghai index more than doubled by mid-June, despite a slowdown in the pace of China’s economic expansion. The surge helped heavily indebted companies from steelmakers to banks sell shares and clean up their balance sheets.

Along the way, though, Chinese authorities put more power in the hands of millions of individual investors by making it much easier for them to buy shares with borrowed money.

Individual investors account for 80% of all transactions in Chinese stock markets. The percentage is far higher than those in the U.S., Europe and other more-developed markets dominated by mutual funds and other professional investors.

The resulting spike in margin loans has come back to haunt Beijing. Outstanding margin loans reached a record 2.27 trillion yuan as of June 18, up from 1.03 trillion yuan at the start of this year—and a roughly fivefold increase in the past year. When investors began to dump stocks in mid-June, that margin debt created a downward spiral where selling begat more selling.


China’s stock market is a small factor in the overall economy. Relatively few individuals own stocks, and most companies get funding through bank loans rather than by selling shares. The bond market in China is one of the largest in the world, but nearly all bonds are bought and held by the country’s huge state-owned banks.

Beijing seems to have been caught off-guard by the monster it helped create in Chinese stock markets; after all, it had managed to tame the currency and property markets before. Last year, authorities engineered a sharp devaluation of the yuan after investors flooded the country with money in hopes that the currency would keep rising. The government’s move worked. The devaluation sent wounded investors fleeing and halted the wave of incoming cash.

When risky real-estate lending exploded two years ago, the central bank intervened by jacking up money-market interest rates to choke off the source of funds for shadow banks driving the boom. The central bank then steadied the financial system with big funding injections into the money markets.

The slide in stock prices has revealed a shortage of ammunition and experience by Chinese authorities. More than two weeks ago, the central bank lowered interest rates again in an attempt to prop up stock prices.

But few individual investors can borrow at those interest rates, so the selling continued. Last weekend, the government launched a raft of measures to boost the market, including raising the amount of money available for margin lending. Few investors who had already suffered big losses had the stomach to borrow even more money to buy stocks.

In another alarming sign, more than 1,300 Chinese companies have suspended trading in their shares on the Shanghai and Shenzhen markets to prevent additional declines. In the last six trading days, the percentage of Shanghai-listed companies that traded no shares rose to 33% from 11%, according to data from FactSet. In Shenzhen, it jumped to 55% from 19%.

Some investors say their confidence is further eroded whenever authorities suggest that the selloff is an overreaction. The People’s Daily, the ruling Communist Party’s mouthpiece newspaper, wrote in an editorial earlier this week: “Rainbows always appear after rains.”

On Wednesday, a spokesman of the China Securities Regulatory Commission, Deng Ge, described the current market mood as “panic sentiment.” He said in a statement: “Irrational selloffs have increased greatly and that has led to a liquidity tension in the stock market.”

Mark Lu, a retail investor in Shanghai, said Wednesday that he has “no faith that the government can save the market. The government is the director of this round of [the] bull market.…On the surface, they seem to be carefully fostering the market, but I am not sure what their real intention is.”